December 15, 2018

Smart Contracts: Neither Smart nor Contracts?

Karen Levy has an interesting new article critiquing blockchain-based “smart contracts.”  The first part of her title, “Book-Smart, not Street-Smart,” sums up her point. Here’s a snippet:

Though smart contracts do have some features that might serve the goals of social justice and fairness, I suggest that they are based on a thin conception of what law does, and how it does it. Smart contracts focus on the technical form of contract to the exclusion of the social contexts within which contracts operate, and the complex ways in which people use them. In the real world, contractual obligations are enforced through all kinds of social mechanisms other than formal adjudication—and contracts serve many functions that are not explicitly legal in nature, or even designed to be formally enforced.

To review, “smart contracts” are a feature of some blockchain-based systems, which allow an interaction between multiple parties to be encoded as a set of rules which will be executed automatically by the system, so that neither the parties nor anyone else can prevent those rules from being enforced. There are lots of variations on the basic idea, which differ in aspects such as exactly what kind of code is used to program the rules, what kinds of actions can be expressed in a ruleset, and so on.

A simple example is an escrow arrangement, where Alice puts some money into escrow, and the money is released to Bob later if an arbiter Charlie determines that Bob performed some required action; otherwise the money returns to Alice. An escrow mechanism can be encoded as a “smart contract” so that once put into escrow the funds can only be disbursed to Alice or Bob, and only as specified by Charlie. Additional features, such as (say) splitting the money 50/50 between Alice and Bob if Charlie fails to act, can be built in. Indeed, the whole idea is that complicated rules can be encoded and then automatically executed with no dispute or appeal possible.

Karen’s argument, that contracts serve functions that are not merely legal, is correct–and that is one reason why “smart contracts” may not be street-smart.  But in addition to failing to do the non-legal work that contracts do, “smart contracts” also fail to do much of the legal work that contracts do, because they don’t work in the same way as contracts.

To give just one example, a legal contract need not try to anticipate absolutely every relevant event that might occur. If some weird thing happens that is not envisioned in a regular legal contract, the parties can work out a modification to the contract that seems reasonable to them, and failing that, a judge might decide the outcome, subject to established legal principles.  Similarly, a single error or “bug” in writing a regular contract, causing its literal meaning to differ from what the parties intended, is unlikely to lead to extreme results because the legal system will often resolve such a problem by trying to be reasonable.

Contrast this with “smart contracts” where a bug in a “contract’s” code can lead to a perverse result that may allow one party to exploit the bug, extracting much of the value out of the arrangement with no recourse for the other parties. That’s what happened with the DAO in Ethereum, leading to a controversial attempt to unwind a legal-according-to-the-rules set of transactions, and dividing the Ethereum community.

So if “smart contracts” may not be smart, and may not be contracts, what are they? It’s best to think of them not as contracts but as mechanisms. A mechanism is a sort of virtual machine that will do exactly what it is designed to do. Like an industrial machine, which can cause terrible damage if it’s not designed very carefully for safety or if it is used thoughtlessly, a mechanism can cause harm unless designed and used with great care.  That said, in some circumstances a mechanism will be exactly what you need.

Discarding the term “smart contract” which promises too much in both respects–being sometimes not smart and sometimes unlike a contract–and instead thinking of these virtual objects as nothing more or less than mindless mechanisms is not only more accurate, but also more likely to lead to more prudent application of this powerful idea.

 

 

Comments

  1. Yes, neither contract nor smart. Instead, a bit of open source, modular, business software functionality – like a bank or merchant website widget. But precisely because it is open source and modular, it can drive standardization, be inspected, harmonize the transactions and commoditize the intermediaries.

    If smart contracts reference legal text (“prose objects” in the Ricardian paradigm), they can wrap themselves in legal framing, effect and recourse.

    Combining modular software functionality and prose objects can codify and open the legal and tech infrastructure of transacting.

  2. Kamil Choudhury says:

    Like pretty much everything else having to do with blockchains, smart contracts are a hugely energy-inefficient implementation of an idea that has been implemented in finance already: conditional aging events (“an option shall age into stock if a condition is met, or expire worthless”). The justification for the aging process still derives validity from an external legal system which cannot be abstracted away into code.

  3. I’m skeptical of all things blockchain, mainly for two reasons. The first is the fact that I don’t understand the key concepts. Learning is a very individual thing, and often the key to learning is finding the instructor, tutorial, expository treatment, etc. that covers the subject in a way that is in tune with the learner’s particular learning style, multiple intelligences pattern, what have you. The sad fact in my case is that I have yet to find the explanation of blockchain that clicks with me in particular. The second reason I haven’t warmed to blockchain is because mosbunall Bitcoin advocates stress the “hard currency” (inflation resistant) aspects of Bitcoin as a feature, and I’m just a little too sold on things like Keynesianism and MMT to see such a theory as an unalloyed good.

    Nevertheless, sometimes people with stated goals that I share sometimes say “never mind Bitcoin, the blockchain has applications other than alt-currencies and has implications that serve our side.” “OK,” I say, and I check out their resources for blockchain theory and as usual, to my particular neural wiring it’s still clear as mud.

    I find the claims (probably spurious, as you demonstrate) of self-enforcing contracts more than a little alluring, even though I don’t begin to understand blockchain. This is because I find contracts as we know them to be inherently oppressive. Let’s say for the sake of argument that I’m one of those people who have a default tendency to take things literally; to take statements at face value. Mind you, I’m not claiming to be such a person. Let’s just say I haven’t ruled out the possibility. Certainly, given a 90-day warranty, my natural tendency on day 91 is to assume the viewpoint of the drafters of the contract is “don’t even ask.” At a purely intellectual level I’m aware that treating all contracts as if they “will” be enforced is probably a sucker’s game. I suppose I could inquire about warranty service on day 91. Looking at it objectively, what’s the worst that could happen? And yet I don’t. I suppose I have only myself to blame for that. And yet dealing with contracts in the more rational way requires far more mental effort on my part than taking them literally does. And so (in my imagination, at least) the contract becomes a mechanism by which the squeaky wheels extract consumer surplus from the squeaky, mousy meek.

    Social stuff in general is absolutely my weak suit, so focusing on the technical form of contract (or as I would say, the “well defined” aspects of it) to the exclusion of the social contexts is absolutely something I see as a feature rather than a bug. I simply adore the idea that if the facts, relative to the contractual stipulations, are on my side, the interpretation of the “smart” “contract” WILL be in my favor. I’m sick of fighting for what’s rightfully mine. If a set of well-defined conditions is a silences debate, that makes me very happen, as negotiating is the most draining thing in the world to me. Still, I can’t ignore the tribal (that is, ideological) patterns surrounding who’s enthusiastic about blockchain (especially its Bitcoin manifestation) and who isn’t. That pattern alone suggests the possibility that when “smart” “contracts” arrive, they will be designed for an even lower probability that the facts, relative to the contractual stipulations, will ever be on my side. If that effect more than offsets the welcome reduction in role for negotiation, then of course adoption of a “smart” “contract” is a net negative for me.